Brief for the Respondents in Opposition — Raytheon Production Corp. v. Commissioner

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INDEX

Opune! s below

Jurisdiction

Question presented

Statute

involved

Statement

CITATIONS

Cases:

Bowers v. Kerbaugh-Empire Co., 271 U.S. 170

gurnet v. Houston, 283 U.S. 223

Burnet Nanford & Brooks Coa, 282 U.S. 309

Contral Re. Co. v. Commissioner, 79 F. 2a 697

! ev. Commissioner, 35 B.'T. A. 1001

Detroit Edison Co. v. Comimisstore 319 U. 8. 98

Dobsov v. Commissioner, 320 U.S. 489

stoner, 321 U.S. 560

Farmers’ & Merchants’ Bank v. Commissioner, 59 F. 2d

912

Helvering v. Nat. Grecery Co., 304 U.S. 282

Kieselbach v. Commissioner, 317 U.S. 399

Southern Ri. Co. v. Comainissroner, 74 F. 2d 887

Sterting Vv. Commissioner,

303 U.S. 663.

United States v. Safety Car Heating Co., 297 U.S. 88

Wilmington Co. v. Helvering, 316 U.S. 164

Statute:

fevenue Act of 1936, ¢. 690, 49 Stat. 1648:

Sec. ;

See. 111

See. 112

See. 113

617027 {4

43 F. 2d 304, certiorari denied,

12

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Gnthe Supreme Court of the Wnited States

OcrosperR TERM, 1944

No. 609

RaYTHEON PropUCTION CORPORATION, PETITIONER

v.

CoMMISSIONER OF INTERNAL REVENUE

ON PETITION FOR A WRIT OF CERTIORARI TO THE UNITED

STATES CIRCUIT COURT OF APPEALS FOR THE FIRST

CIRCUIT

BRIEF FOR THE RESPONDENT IN OPPOSITION

a

OPINIONS BELOW

The findings of fact and opinion of the Tax

Court (R. 16-31) are reported in 1 T. C. 952.

The opinion of the Cireuit Court of Appeals (R.

139-147) is reported in 144 F. 2d 110.

JURISDICTION

The judgment of the Cireuit Court of Appeals

was entered on July 28, 1944 (R. 147). The peti-

tion for a writ of certiorari was filed on October

18, 1944. The jurisdiction of this Court is in-

voked under Section 240 (a) of the Judicial Code,

as amended by the Act of February 13, 1925.

(1)

2

QUESTION PRESENTED

A lump sum payment was made to the taxpayer

in compromise of a suit for damages allegedly re-

sulting from violation of the federal antitrust

laws and the taxpayer failed to show the cost or

other basis of its good will which had been de-

stroyed. The question is whether the entire com-

promise payment is taxable income.

STATUTE INVOLVED

The pertinent statutory provisions are printed

in the Appendix, infra, pp. 11-12.

’ >

STATEMENT

The facts as found by the Tax Court (R. 17-25)

may be summarized, as follows:

The taxpayer, Raytheon Production Corpora-

tion, came into existence as a result of a series of

tax-free reorganizations which are not here in-

volved. The original and suceessor companies will

be referred to as ‘‘Raytheon’’. The original Ray-

theon Company was a pioneer manufacturer of a

rectifying tube which made possible the operation

of a radio receiving set on alternating current in-

stead of on batteries. In 1926 its profits were

about $450,000; in 1927 about $150,000; and in

1928, $10,000. (R. 17.)

The Radio Corporation of America (hereinafter

termed R. C. A.) had many patents covering radio

circuits and claimed control over almost all of the

—oOCOo — 2 —

3

practical circuits. Cross-licensing agreements had

been made among several companies including

R. C. A., General Electric Company, Westinghouse,

and American Telephone & Telegraph Company.

R. C. A. had developed a competitive tube which

produced the same type of rectification as the

Raytheon tube. Early in 1927, R. C. A. began to

license manufacturers of radio sets, and in the

license agreement it incorporated ‘Clause -",

which provided that the licensee was required to

buy its tubes from R. C. A. In 1928 practically

all manufacturers were operating under R. C. A.

licenses. As a consequence of this restriction,

Raytheon was left with only replacement sales,

which soon disappeared. (R. 17-18.)

When Raytheon found it impossible to market

its tubes in the early part of 1929, it obtained a

license from R. C. A. to manufacture tubes under

the latter’s patent on a royalty basis. The license

agreement contained a release of all claims of

Raytheon against R. C. A. by reason of the illegal

acts of the latter under Clause 9, but by a side

agreement such claims could be asserted if R. C. A.

should pay similar claims to others. The tax-

payer was informed of instances in which R. C. A.

had settled claims against it based on Clause 9.

On that ground it considered itself released from

the agreement not to enforce its claim against

R. ©, A. and consequently, on December 14, 1931,

the taxpayer caused its predecessor, Raytheon, to

a

bring suit against R. C. A. in the United States

District Court for the District of Massachusetts

alleging that the plaintiff had by 1926 created and

then possessed a large and valuable good will in

4

interstate commerce in rectifying tubes for radios

and had a large and profitable established business

therein so that the net profit for the year 1926 was

$454,935; that the business had an established

prospect of large increases and that the business

and good will thereof Ws of a value sf exce eding

$3,000,000; that by the beginning of 1927 the

plaintiff was doing approximately 80 per cent of

the business in rectifying tubes of the entire

United States; that the defendant conspired to

destroy the business of the plaintiff and others by

a monopoly of such business and did suppress and

destroy the existing companies; that the manufae-

turers of radio sets and others ceased to purchase

tubes from the plaintiffs; that by the end of 1927

the conspiracy had completely destroyed the prof-

itable business and that by the early part of 1928

the tube business of the plaintiff and its property

and good will had been totally destroyed at a time

when it had a present value in excess of $3,000,000,

and thereby the plaintiff was injured in its busi-

ness and property in a sum in excess of $3,000,000.

(R. 19-20.)

The action against R. C. A. was referred to an

auditor who filed a report on February 14, 1938.

He found that Clause 9 was not the cause of dam-

st

tie

SR ae

a! —

o

age to the plaintiff but that the decline in plain-

tiff’s business was due to advancement in the radio

art and competition. (R. 20-21.) The auditor

also found that if the plaintiff was entitled to re-

covery by reason of Clause 9 the damages were

estimated at $1,000,000 (R. 141).

In the spring of 1938, after the auditor’s report

and just prior te the time for the commencement

of the trial before a jury, the Raytheon affiliated

companies began negotiations for the settlement

of the litigation with R. C. A. In the meantime,

a suit brought by R. C. A. against the taxpayer

for the non-payment of royalties resulted in a

judgment of $410,000 in favor of R ©... SB.

R. GC. A. and the taxpayer finally agreed on the

payment by R. C. A. of $410,000 in settlement of

the antitrust action. (R. 21.) A written plan of

settlement was carried out under the terms of

which mutual releases of any claims against the

other were executed and Raytheon granted to

R. C. A. certain patent license rights and subli-

censing rights to a group of patents. R. C. A.

declined to allocate the amount paid as between

the patent license rights and the amount for the

settlement of the suit. (R. 21-23.) Officials of

the Raytheon companies ascribed $60,000 of the

$410,000 to the value of the patents and allocated

$350,000 as a credit to surplus (R. 24).

In its income tax return for the fiscal ycar 1938,

the taxpayer treated the $350,000 as a realization

6

from a chose in action and not as taxable income.

The Commissioner determined that the $350,000

constituted income. (R. 24.) The Tax Court

sustained the Commissioner (R. 16) and the Cir-

cuit Court of Appeals affirmed (R. 147).

ARGUMENT

This case involves the question of what part of

& temp sum settlement received in compromise of

litigation ean be ascribed to a replacement of cap-

ital and what part to income. That is a factual

question for determination by the Tax Court.

Helvering Vv. Nat. Grocery Co., 304 U.S. 282, 294;

Wilmington Co. v. Helvering, 516 U. &, 164, 168:

Dobson v. Commissioner, 320 U.S. 489. Appor-

tionment, between claims for undermaintenance

(a capital item) and for additional compensation

(taxable income), of a lemp sum settlement. re-

ceived by a railroad from the Direetor General of

Railroads was held to be purely a fact question in

Southern Ry. Co. v. Comirissioner, 74 F, 2a 887,

893 (C. C. A. 4th). The facts there are strikingly

similar to the instant case since no apportionment

of the fund was made by the Director General.

The burden of proof, in the instant case, to show

what part of the payment by R. C. A. was a re-

placement of capital, rested upon the taxpayer

and in that it failed. HEquitable Society vy. Com-

missioner, 321 U. S. 560, 563-564; Burnet v.

Houston, 283 U. 8. 223, 227-228.

—

7

It is immaterial whether the transfers of assets

between the various companies were tax-free re-

organizations or not. If we assume that they

were, then the taxpayer must show the cost of the

good will, alleged to have been destroyed, of Ray-

theon, the predecessor owner.’ If not, the tax-

payer must show its own cost for the elaim or

chose in action. No value was ascribed to the claim

as such in any of the tax-free transfers from com-

pany to company. There is no proof of cost to any

of the various corporate holders including the

taxpayer. A replacement of capital loss is tax

free only above the basis of cost. Detroit Edison

Co. v. Commissioner, 319 U.S. 98, 101-102. Dam-

ages received for property seized under condem-

nation present a clear analogy. In such eases cap-

ital cost may be recovered tax free but any amount

received above the cost basis results in taxable

income. Aieselbach v. Commissioner, 317 U.S.

399, 404-405. And compensatory damages paid as

the result of a suit for breach of warranty were

held taxable as income in Burnet v. Sanford &

Brooks Co., 282 U.S. 359.

The Tax Court held that the cost or other basis

of Raytheon’s good will and business was not

shown and that therefore the amount of any non-

taxable capital recovery could not be ascertained

‘Since the taxpayer retained its physical assets, the cost

basis of good will and the cost of developing its rectifier tube

are the only capital items involved.

etic ES ier eee SRST ES RIS SER A EER ENE TEU MINED IIE MAM SAE OU RET I PI i I rr SM Fa

MEH «

8

(R. 29). A similar situation existed in Sterling vy.

Commissioner, 93 F. 2d 304, 306 (C. C. A. 2d),

certiorari denied, 303 U. S. 662. where the tax-

payer failed to prove the March 1, 1915, value of

her claim to an interest in real estate and was

therefore taxed on the entire amount received in

au compromise settlement of her claim.

The Cireuit Court of Appeals held that com-

pensation for the loss of Raytleon’s good will in

excess of its cost would be gross income and that

“the record is devoid of evidence as to the amount

of that basis’’ (R. 146). There is present here a

total failure of proof which is fatal to the tax-

payer’s contention of a tax-exempt capital replace-

ment. It cannot be said on this record that

$350,000, a figure arbitrarily fixed by interested

officers of the taxpayer, represented a capital re-

placement.

The contention that damages for injury to an

intangible capital asset can never be income ( Pet.

7, 10-12) is not supported by the cases cited.

Bowers v. Kerbaugh-Empire Co., 271 U. 8S. 170,

172, involved a situation where the excess of losses

of the taxpayer over income was more than the

amount claimed by the Government to have been

taxable as income in 1921. The question was

whether the difference between the value of marks

measured by dollars at the’time of repayment of

a loan and the value when the loans were made

was income. The facts showed continuous losses

>

9

in 1913 to 1918 and this Court said (271 U.S. at

p. 175): “The result of the whole transaction was

a loss’. Cf. Burnet v. Sanford & Brooks Co.,

282 U.S. 359.

While this Court in United States v. Safety

Car Heating Co., 297 U.S. 88, 98, referred to an

injury to capital as not resulting in income, the

facts in that ease show that the recovery was less

than the March 1, 1913, value. The dictum relied

on by the taxpayer (Pet. 11-12) cannot be given

the effect of overruling the well-established doc-

trine that capital gains constitute taxable income.

We do not find a conflict among the decisions

of the Cirenit Courts of Appeals as contended

(Pet. 7, 9-10). As pointed out by the Circuit

Court of Appeals (R. 146-147) in Farmers’ &

Merchants’ Bank v. Commissioner, 59 F. 2d 912

(C. C. A. 6th), the plaintiff’s bank business was

injured and the compensation paid was to recoup

for the injury. The court’s reasoning merely deals

with the nature of the recovery and it assumes

that since the recovery was not for lost profits, it

did not constitute income. It may not be inter-

preted as a clear holding that a recovery of capital

is not income even though in excess of the basis.

See Davis v. Commissioner, 35 B. T. A. 1001,

1013-1015.

Central R. Co. v. Commissioner, 79 F. 2d 697

(C. C. A. 3d), involved the question whether the

amounts realized through impressing a trust upon

5 Pigitec¥eeak:

_ elena ——_- oe aie PRP R Po COE Pre I eee eee ee

10

the earnings of a fiduciary could properly be

treated as income of the cestui. The court held

(79 F. 2d at p. 699) that the amount received was

not income of the rattroad™ but 2 penalty imposed

by law on a faithless fiduciary named Joyce for

double dealing. “The ultra vires operations of the

fiduciary were not carried on by the use or the

capital and Tabor-of the railroad but were sep-

arate and apart from the latter’s business struc-

ture. , aaa:

Both of the above cases are discussed in Ster-

ling v. Commissioner, 93 F. 2d 304, 306 (C. C. A.

2d), in which this Court denied a petition for cer-

tiorari, 303 U. S. 663.

CONCLUSION

The decision below is correct. There is no con-

flict of decisions and the petition for certiorari

should be denied.

Respectfully submitted.

CuHarLeES Fany,

Solicitor General.

SaMUEL O. CLarK, Jr.,

Assistant Attorney General.

SEWaLL Key,

J. Louis Monarcu,

Newton K. Fox,

Special Assistants to the Attorney General.

NOVEMBER 1944.

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